QSPEs, Derivatives, and FAS 140

FASB plans to require that, in order to receive sales accounting treatment, a qualifying special purpose entity should be subject to revenue recogn...
Ed ZwirnJuly 11, 2005

As a summer project, the Financial Accounting Standards Board is preparing an exposure draft of its revision of Financial Accounting Standards No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities.

The board’s FAS 140 project received extra impetus in February, when mortgage lender Countrywide Financial fell afoul of its provisions and was forced to issue a restatement of its 2004 financial results. The revision, which amounted to 20 cents per share of net earnings, also forced Countrywide to disclose a material weakness in its internal controls in its 2004 annual report.

The draft — due in August, followed by a 60-day comment period — will likely take effect around June 2006. The board has also decided to address many concerns of the financial community by issuing a FASB staff position providing interim guidelines until the revised FAS 140 takes effect.

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Wednesday’s FASB session dealt with one aspect of the soon-to-be-issued staff position. Board members decided to revise paragraphs 40B and 40C of FAS 140 to require that, in order to receive sales accounting treatment, the qualifying special purpose entity (QSPE) be subject to revenue recognition tests only at the time a deal involving derivative securities is made. In other words, says Ernst & Young partner David Thrope, co-chair of the Commercial Mortgage Securities Association’s FASB Monitoring Committee, generally these deals would not be subject to ongoing tests.

Under these revisions, if an unanticipated volume of prepayments shifted the outlook for the derivatives, profit-and-loss figures would not need to be adjusted, let alone restated. Board members also called for the FASB staff to clarify how the staff position would deal with situations in which the transferor of the securities also acted as a market maker.

“The Countrywide problem has sensitized people to the derivatives issue,” observes Thrope. “The concern is that if you have a derivative that’s a QSPE on day one, things could happen in the future.” He notes that the planned staff position would alleviate at least some concerns by “reducing the research” needed to ensure adherence to accounting principles.

Dennis Hild, vice president of accounting at America’s Community Bankers, an industry lobbying group, says that his group has another big concern with the upcoming FAS 140 revision: its possible effect on the “true sale at loan agreements” that govern loan participations. According to Hild, these agreements — which greatly expand a bank’s lending capacity by letting it “participate out” portions of a loan without violating state-imposed lending ceilings — must be allowed sale treatment to remain economically feasible. “It would be hard to justify doing a loan participation if you can’t do sale accounting,” says Hild.

In other business, the board agreed that disclosures required under its Derivatives Disclosure project would be limited to the derivatives already governed by Financial Accounting Standard 133, Accounting for Derivative Instruments and Hedging Activities, and the securities they hedge, according to FASB practice fellow Stuart Moss.

In the case of an interest-rate swap, this would mean the swap itself plus the underlying, usually variable, instrument for which the swap had been put in place to “lock in” the rate and minimize risk should rates go the wrong way. The changes, which do not effect accounting per se but only govern disclosure, are being made because “there were some concerns by constituents that the current disclosure requirements didn’t necessarily address risk,” says Moss.

In addition, last week FASB issued two releases:

• One package of releases concerns Emerging Issues Task Force Consensus in Issue No. 04-5, “Determining Whether a General Partner, or the General Partners as a Group, Controls a Limited Partnership or Similar Entity When the Limited Partners Have Certain Rights,” and an amendment to Issue No. 96-16, “Investor’s Accounting for an Investee When the Investor Has a Majority of the Voting Interest but the Minority Shareholders Have Certain Approval or Veto Rights.”

The guidance on EITF 04-5 is effective as of June 29 for general partners of all limited partnerships for which the partnership agreements are modified, and for all others as of the first reporting period in fiscal years beginning after December 15. For EITF 96-16, the guidance is effective as of the ratification date, June 29.

• The other, a draft abstract concerning EITF Issue No. 04-13, “Accounting for Purchases and Sales of Inventory with the Same Counterparty,” would govern 1) The circumstances under which two or more transactions with the same counterparty should be viewed as a single non-inventory transaction within the scope of Opinion 29, and 2) whether there are circumstances under which non-monetary exchanges of inventory within the same line of business should be recognized at fair value. Comments due August 20.

Looking ahead, FASB will be on a lighter schedule for at least the next couple of weeks. This Wednesday’s meeting, which is educational in nature only, will start at 1 p.m. and involve discussion of topics to be addressed at the July 27 meeting; no topics have been announced for July 20.